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More on Bernanke's “Bad News Principle”

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  • Yishay D. Maoz

    (University of Haifa)

Abstract

The role that Bernanke’s Bad News Principle plays in the modern theory of investment under uncertainty is analyzed. The analysis shows that the actual investment dilemma is that by delaying investment firms trade off a higher present value of earnings for a lower present value of the investment cost, in contrast to previous interpretations of this dilemma. The economic interpretation of the Smooth Pasting Condition is clarified too: it represents the trade-off mentioned above. I also show that investment triggers may stay intact despite changes in the profit process, if the changes are restricted to the range of sufficiently high profits.

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File URL: http://128.118.178.162/eps/get/papers/0510/0510002.pdf
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Bibliographic Info

Paper provided by EconWPA in its series General Economics and Teaching with number 0510002.

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Length: 30 pages
Date of creation: 09 Oct 2005
Date of revision:
Handle: RePEc:wpa:wuwpgt:0510002

Note: Type of Document - pdf; pages: 30
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Web page: http://128.118.178.162

Related research

Keywords: Investment; Uncertainty; Option Value; Competition;

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  1. Sodal, Sigbjorn, 1998. "A simplified exposition of smooth pasting," Economics Letters, Elsevier, vol. 58(2), pages 217-223, February.
  2. Dixit, Avinash & Pindyck, Robert S & Sodal, Sigbjorn, 1999. "A Markup Interpretation of Optimal Investment Rules," Economic Journal, Royal Economic Society, vol. 109(455), pages 179-89, April.
  3. Dixit, Avinash, 1991. "Irreversible Investment with Price Ceilings," Journal of Political Economy, University of Chicago Press, vol. 99(3), pages 541-57, June.
  4. Robert S. Pindyck, 1991. "Irreversibility, Uncertainty, and Investment," NBER Working Papers 3307, National Bureau of Economic Research, Inc.
  5. Dumas, Bernard, 1991. "Super contact and related optimality conditions," Journal of Economic Dynamics and Control, Elsevier, vol. 15(4), pages 675-685, October.
  6. Drazen, Allan & Sakellaris, Plutarchos, 1999. "News About News: Information Arrival and Irreversible Investment," Macroeconomic Dynamics, Cambridge University Press, vol. 3(03), pages 451-462, September.
  7. Robert C. Merton, 1973. "Theory of Rational Option Pricing," Bell Journal of Economics, The RAND Corporation, vol. 4(1), pages 141-183, Spring.
  8. Bar-Ilan, Avner & Strange, William C, 1996. "Investment Lags," American Economic Review, American Economic Association, vol. 86(3), pages 610-22, June.
  9. Leahy, John V, 1993. "Investment in Competitive Equilibrium: The Optimality of Myopic Behavior," The Quarterly Journal of Economics, MIT Press, vol. 108(4), pages 1105-33, November.
  10. Dixit, Avinash, 1991. "A simplified treatment of the theory of optimal regulation of Brownian motion," Journal of Economic Dynamics and Control, Elsevier, vol. 15(4), pages 657-673, October.
  11. Tarun Sabarwal, 2005. "The non-neutrality of debt in investment timing: a new NPV rule," Annals of Finance, Springer, vol. 1(4), pages 433-445, October.
  12. Dixit, A., 1988. "Entry And Exit Decisions Under Uncertainty," Papers 91, Princeton, Department of Economics - Financial Research Center.
  13. Kongsted, Hans Christian, 1996. "Entry and exit decisions under uncertainty: The limiting deterministic case," Economics Letters, Elsevier, vol. 51(1), pages 77-82, April.
  14. repec:cup:macdyn:v:3:y:1999:i:3:p:451-62 is not listed on IDEAS
  15. Allan Drazen & Plutarchos Sakellaris, 1999. "News About News: Information Arrival and Irreversible Investment," NBER Technical Working Papers 0244, National Bureau of Economic Research, Inc.
  16. Avinash Dixit, 1992. "Investment and Hysteresis," Journal of Economic Perspectives, American Economic Association, vol. 6(1), pages 107-132, Winter.
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